Crisis management: Investing in a low-growth economy

The below graph reflects the ongoing decline in real gross domestic product, or GDP, and consumption growth rates in the USA, calculated as a simple three-year moving average. This data has been arranged by the Presidential Administration in order to chronicle secular (long-term) trends in the real economy within a political and historical context, providing perspective on reasonable expectations for the future. As the below graph reflects, the Obama Administration has been facing an uphill battle against long-term deteriorating data, though recent signs of economic growth are starting to change the picture. This ten-part series examines the U.S. macroeconomic factors driving U.S. equity markets and the implications for U.S. equity investors.

Based on three-year rolling averages, we see that both consumption and GDP growth rates have been on long-term declines in the USA. It’s important to note that this data has ranged quite widely over the years, as different political administrations with differing monetary and fiscal policies have reversed negative trends—though not in a particularly sustainable fashion post-1964. Plus, as noted in a prior series, investment has also been on a long-term decline in the USA. The major declines in consumption and GDP growth in the above graph also reflect in investment data, and the economic cycles or crisis associated with the above swings in the data are explained further in the related article Consumption is no substitute for investment, noting that excess consumption in the U.S. economy is no substitute for growth-enhancing long-term investments.

To see how government spending may affect future tax policy and equity prices, please see the next article in this series.

Equity Outlook: Cautious

Should the debt ceiling debate re-emerge after the mid-term elections in November, and macroeconomic data fail to rebound in sync with record corporate profits, investors may wish to consider limiting excessive exposure to the US domestic economy, as reflected more completely in the iShares Russell 2000 Index, IWM. Alternatively, investors may wish to consider shifting equity exposure to more defensive consumer staples-related shares, as reflected in the iShares Russell 1000 Value Index, IWD.

Additionally, even the global blue chip shares in the S&P 500 or Dow Jones could come under pressure in a rising interest rate environment accompanied by slowing consumption, investment, and economic growth. As such, investors may exercise greater caution when investing in the State Street Global Advisors S&P 500 SPDR, SPY, or the State Street Global Advisors Dow Jones SPDR, DIA, ETF’s. Until there is greater progress on the budget and federal debt issue, and consumption, investment and GDP start to show greater signs of self-sustained growth, investors may wish to exercise caution, and consider value and defensive sectors for investment, or individual companies such as Wal-Mart Stores, WMT).

Without a sustained improvement in economic growth data, there is little doubt that the debt level issue and tax reform will be a big issue later in the year. Current economic data noted in this Series suggests that the probability of the 2013 sequester issue returning—in one form or another—could be higher than many think. The data is simply not that robust—yet.

Equity Outlook: Constructive

However, if investors are confident in the ability of the USA to sustain the current economic recovery as a result of the improving macroeconomic data noted in this Series, they may be willing to take a longer-term view and invest in US equities at their current prices. With the S&P 500 Price/Earnings ratio standing at 19.65, versus the historical average of around 15.50, the S&P is slightly rich in price, though earnings have been solid. However, with so much wealth sitting in risk-free and short-term financial assets, it is possible to imagine that a large reallocation of capital that is “on strike”, to include corporate profits, into long-term fixed investments could lead to greater economic growth rates in the future, and support both higher equity and housing prices in the future as well. In the case of a constructive outlook, investors should consider investing in growth through the iShares Russell 1000 Growth Index (IWF), or through individual growth oriented companies such as Google (GOOG).

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